Many months ago, I was in on an email exchange between a couple of our China lawyers regarding a liquidated damages provision in a product development agreement where our client was paying a Chinese manufacturer a lot of money to develop a new product that could be taken into production. Our biggest concern with the product development arrangement was that the Chinese manufacturer would sell the product to others after our client paid the large sum of money to have it developed.  So we wrote the contract to prohibit that and to give that provision added force we put in a liquidated damages provision listing out exactly how much our client would be entitled to in damages were the Chinese manufacturer to violate the non-compete provision forbidding them from making the product for anyone else.
Wikipedia nicely defines liquidated damages as follows:
Liquidated damages (also referred to as liquidated and ascertained damages) are damages whose amount the parties designate during the formation of a contract for the injured party to collect as compensation upon a specific breach (e.g., late performance).

We really like liquidated damages provisions in our China contracts because Chinese courts tend to view contractual liquidated damages provisions very favorably and so long as they are not unreasonable, they will usually be enforced. Most importantly, courts will seize Chinese company assets based on a liquidated damages provision and they will seize these assets before trial. Chinese companies know and fear this. A well-crafted China contract with a well-crafted liquidated damages provision is one of the best tools out there for preventing your Chinese counter-party from breaching your agreement, and that is the primary reason for having a contract in the first place.

In this particular product development contract, we put in a high number for the liquidated damages provision and the Chinese side immediately accepted it. This led co-blogger Steve Dickinson to write the following email:

Yes, _________  [our client] asked for a high number and I put it in at their request. Interestingly, the Chinese side signed with no complaint and with no objection from their Chinese attorneys either. I think that Chinese companies that do not plan to default simply don’t have a problem with contract damage numbers in this kind of agreement. The companies that complain are to be viewed with caution.

In terms of contract damages, it is important to be clear. As with the US, the number is not intended as a penalty. It is intended as an honest effort by the parties to predict damages in advance. If the number is too low, the injured party can ask for more. If the number is too high, the defendant can ask for a reduction. In either case, the validity of the contract itself is not affected.  The advantage of liquidated damages is that it gives you a sum certain when you go to the court to ask for preliminary relief such as seizure of assets. As long as a court is involved, the Chinese companies know that prejudgment asset seizure based on the amount of contract damages is a real risk and this makes them much more compliant in dealing with these issues. Where arbitration is involved, liquidated damages has far less utility, which is yet another reason why international lawyers should not be so quick to jump for having China contract disputes resolved via arbitration.
For more on the effectiveness of liquidated damages provisions in China contracts, check out the following:

Whenever I am asked to review a contract between a US company and a China company, I nearly always go straight to the dispute resolution clause.

Much of the time when I am asked to review such a contract, it is by someone who did not use our law firm to draft the contract and is now asking us to review their contract because something has gone wrong.  I review the dispute resolution clause first to see if there is even any point in determining the strength or the weakness of the US company’s claims against the Chinese company. If the contract calls for litigation in the United States, before a US Court and the Chinese company has no assets in the United States, the quality of the case just went way down.

The reason is that China does not enforce US court judgments. So what this means is that if your contract requires that all disputes between you and your Chinese counter-party must be resolved in a US court, you will be required to sue the Chinese company in a US court.  But since China will not enforce any judgment that you receive from the US court, your winning in the US court will likely be meaningless.  Getting a US judgment against a Chinese company with assets only in China is of no use.  Getting a US judgment against a Chinese company that has assets in the United States or in some other country that will enforce a US judgment (Korea and Canada spring immediately to mind) might have some value.

Way back in 2006, in Enforcing Foreign Judgments In China — Let’s Sue Twice, we wrote about how a typical phone call goes when someone calls us for help enforcing their US judgment in China:

Caller:  I have a two million dollar judgment against Chinese company X in China, can you help me enforce it?

Me:  Is it a default judgment here in the United States?

Caller:  Yes.

Me:  Chinese courts do not enforce United States’ judgments and they don’t give any credence whatsoever to United States default judgments. Did you discuss this possibility with your U.S. lawyer before you sued here in the United States?

Caller:  [long silence] …. Yes.  He told me getting a judgment here couldn’t hurt?

Me:  Did your lawyer charge you to get it?

Caller:  Yeah.  I had to pay him and I had to pay all sorts of people to get that company served in China.

Me:  Sorry.

So much of the time in your China contracts, it will make sense to draft a dispute resolution clause with your Chinese counter-party that calls for disputes to be resolved by a Chinese court (or sometimes by arbitration in China or outside of China).  More lawyers are catching on to this and we are seeing fewer contracts that call for US court jurisdiction.  But we are now starting to see contracts that are getting too specific about the Chinese court in which disputes will be resolved.

And that itself can be problematic.

The reason for our concern about overly specific Chinese court jurisdiction provisions is that the Chinese courts tend to ignore any attempt by contracting parties to dictate where a matter will be litigated. Instead, Chinese courts typically determine the proper jurisdiction for a dispute based on the nature of the claim, the amount of the claim, the location of the parties, and the location of the witnesses to the dispute.

If your choice of Chinese court jurisdiction is wrong, the Chinese court will — at best — ignore it. But at worst, your mistake could raise questions about the validity of Chinese Court jurisdiction or create other confusions.  The whole reason for putting in a dispute resolution clause is to avoid the expense, the time, and the uncertainty of where and how to resolve any disputes.  There is therefore no reason to add language that appears to increase certainty, but which in practice will have exactly the opposite effect.

For more on positioning yourself to be able to collect from a Chinese company in litigation/arbitration, check out the following:

If you are not a member of our China Law Blog Group on Linkedin, you should be. Put simply, we have great discussions on China law and China business among our 7600+ members and there is never any spam. I guarantee it.

One of our latest and greatest discussions is on a topic near and dear to my heart: litigation versus arbitration in a China contract.  The discussion started with a US lawyer posing the following question: “Should a Contract Between a Non-Chinese Company and a Chinese Company Require Courtroom Litigation or Arbitration?”  He then went on to sort of answer it himself, with the following:

It seems to me under the NY Convention of 1958 that the following should be the practice of writing contracts:  1) If the dispute is over money damages only – Arbitration OUTSIDE of China is the best practice (Chinese courts have never rejected such arbitration awards and enforce them. 2) If the dispute is over money and personal property (molds for instance) then using Chinese courts is the preferred method.  Counter-argument(s)?

I disagree somewhat in that Chinese courts oftentimes do not enforce foreign (and domestic) arbitration awards. The statistics on this look better than they should because Chinese courts oftentimes will “reject” a foreign arbitral award not by writing an opinion explicitly declining to adopt the foreign arbitration award, but by simply never writing any opinion at all, which itself acts not to enforce the award.

Another US lawyer then said that she thought Hong Kong arbitration makes sense and that China courts are to be avoided. I disagree with this in that even if true, many Chinese companies will not agree to arbitration, but I also disagree with this because Chinese courts do not have all that great a record in enforcing foreign arbitration awards.

A US law intern then said that he “would always use an arbitration clause in any international contract, no matter what the contract was for. Particularly with China, since they are signatories (essentially) to the New York Convention, any arbitration award should be enforceable in Chinese courts, no matter what the contract is for.”  This answer makes some sense on paper, but it fails to account for what actually happens in real life.

A China and New York licensed lawyer then said that the distinction between a money damages and personal property contract is not a good method for determining whether to arbitrate or litigate.  I agree.

A US lawyer then said that he “always” recommends “arbitration” because … the Chinese court system is too unpredictable and too corrupt.”  See my thoughts above.

A Chinese lawyer then said that most Chinese courts are not unpredictable, especially when dealing with clear-cut issues and that “litigation could be pressure for a Chinese company.”  I agree and note that this raises an absolutely essential point.  I am always telling our clients and I am always blogging on the benefits of a good contract with your Chinese counter-party that go beyond the ability to sue and enforce. In Chinese Contracts. Because They Really Do Make A Huge Difference, I set out these three reasons, with one of them being to “put a little scare into your Chinese counter-party”:

The third reason to have a good contract is to put a little scare into your Chinese counter-party.  I call this the “bike-lock theory of Chinese contracts” and I wrote about this too way back in 2006, in China OEM the Smart Way:

The best solution for this is to prevent it from happening in the first place and the best way to do that is to choose the right supplier and use a good OEM contract.  When we draft OEM contracts for our clients, we always put in a provision precluding the Chinese manufacturer from subcontracting out production. Without exception, the Chinese manufacturers have agreed to this provision and, again without exception (at least as far as we know), they have always abided by it.  The reason for this is simple.  The manufacturer may have twenty some companies for whom it produces goods, but probably less than half of them forbid subcontracting.  When the Chinese manufacturer is so busy as to require subcontracting, it makes sense for it to first subcontract out work for those foreign companies for whom it is NOT prohibited by contract from doing so.  I am always analogizing this to bike locks.  Even the best bike lock cannot prevent all thefts, but its efficacy comes from the fact that bike thieves generally find it easier to steal a bike with a poor quality lock or none at all than one that is difficult to break.

Any contract that makes your Chinese counter-party think twice about messing with you has at least some value.  My law firm is constantly settling cases with Chinese companies based on well-written contracts.  Chinese company clearly owes our client a million dollars per a well written contract and we settle for $650,000.  Had it been in the United States, we might not have taken less than $850,000.  But had there been no contract, my firm would not have even taken the case and settlement would likely have been for nothing at all or something really nominal.

Having a well written contract does not mean you will always win your lawsuit if you are forced to sue on it. But it does mean you will have some leverage if things go wrong and it does mean you will at least have a chance. Having no contract means no chance. Hey, it’s your choice.

Chinese companies do not like being sued. Just being sued in China is viewed by many companies as damaging to their reputation.  They especially do not like it if they are going to lose and if enforcement is going to be quick. Being sued in a Chinese court is generally viewed by Chinese companies as worse than being pursued by arbitration.

Another Chinese lawyer then said that he prefers arbitration to litigation, but gave no reason why.  Is it simply because he finds arbitration more enjoyable as a lawyer?

An American lawyer turned businessperson then voted for arbitration and mused about the best place.  He pointed out that just about everyone knows about the benefits of Hong Kong, but that he is a fan of Singapore. I do not think arbitration is always the answer, but I am a fan of Singapore over Hong Kong because the lawyers and the arbitrators tend to cost less in Singapore, but I would hesitate to pick it solely on this basis because I have a sense that a Hong Kong arbitration award is more likely to be enforced on the Mainland than a Singapore one.

Then an American lawyer who frequently represents Chinese companies talked of how those companies like US litigation provisions because that increases their chances of being able to enforce a judgment against their American counterpart, but that testifying in a less formal arbitration setting is oftentimes better for Chinese witnesses.  He then concludes that “there are often downsides and upsides to both settings and, therefore, I find the decision to choose the format (if given that opportunity) is fact specific and dependent on the nature of the dispute, the parties, and the forum options.”  I like what he says.

Then a Canadian lawyer, Paul Jones, wrote what I consider to have been the best answer:

For me it depends first on the most likely type of dispute, the desired remedies and the location of assets.

I read Chinese court decisions almost daily and find that they are generally well-reasoned. The decision of the Shanghai Higher People’s Court in the Johnson & Johnson re-sale price maintenance case is an example of a particularly well-written and well-reasoned judgment.

Common lawyers over-emphasize the issue of precedent. Civil law systems, including those of China, have other, more sensitive ways of ensuring that similar cases are decided in similar ways. I was first trained in common law.

Arbitration is good for large cases, where the remedy sought is money and the amount is over $5 million USD.

For amounts below that it should be remembered that it costs almost as much to have an arbitral award enforced by a court in China as it costs to go to trial. And a very basic arbitration can cost several times what it would cost to go to trial in China.

Further if specific remedies such as an IP injunction, or a seizure of certain assets is being sought, only a court can provide these remedies. Certain types of evidence may only be obtained by a Chinese court order. Arbitration outside China just adds substantial delay and risk to the enforcement of your rights.

The enforcement rate for foreign arbitral awards is about 70% to 80%. Not all are enforced. There are papers and books on this topic.

Chinese courts can be much quicker than many foreign courts. Completion of the matter in 6 months is not unusual. As do other civil law courts they rely more on documentary evidence than oral testimony, so usually there is no need for the foreign executive to attend. There is no discovery. You need to plan your evidence well in advance.

The World Bank Doing Business survey ranks the Chinese court system 19th in the World for the enforcement of contracts, based on time required, cost, and complexity of procedures. I think that this ranking reflects the points that I have used above.

My practice consists of a lot of distribution agreements and IP licenses. The amounts in dispute rarely get up to $5 million, the IP needs injunctive remedies, and the Chinese party usually does not have assets outside the country.

So we usually recommend Chinese law and Chinese courts. We have experience litigating in the Chinese courts.

He completely nails it and his comment is very similar to what we tell our clients all the time.  Breaking it down:

  • “For me it depends first on the most likely type of dispute, the desired remedies and the location of assets.”  Exactly.  In figuring out what we are going to put in the contracts we write between our US clients and their Chinese counterparts, we first sit back and try to figure out the most likely breach of contract scenarios (either by our own client or by the Chinese company) and also the really critical breach of contract scenarios.  A bad delivery of $100,000 in product might be very likely, but that is going to pale in importance to the Chinese company taking over our client’s factory in China and ceasing all deliveries.  So between those two, we would probably write the contract to provide our client with the best forum for dealing with its factory being hijacked.
  • “I read Chinese court decisions almost daily and find that they are generally well-reasoned.”  Again, completely agree. Yes, you should think very hard about avoiding a situation where you find yourself in a Chinese court going up against a powerful company owner in some small city in China’s interior, but the judges in China’s larger and more sophisticated cities, particularly in the higher courts, are often not so bad at all.
  • “Arbitration is good for large cases, where the remedy sought is money and the amount is over $5 million USD. For amounts below that it should be remembered that it costs almost as much to have an arbitral award enforced by a court in China as it costs to go to trial. And a very basic arbitration can cost several times what it would cost to go to trial in China.”  I agree, but would hedge it a little by saying that arbitration is “generally” good for large money damages cases.
  • “Further if specific remedies such as an IP injunction, or a seizure of certain assets is being sought, only a court can provide these remedies. Certain types of evidence may only be obtained by a Chinese court order. Arbitration outside China just adds substantial delay and risk to the enforcement of your rights. The enforcement rate for foreign arbitral awards is about 70% to 80%.” I agree and this is key. Much of the time, the biggest risk to the American company is not money, not the one bad shipment, not the long delay.  Much of the time, the biggest risk to the American company is that the Chinese company will run away with the American company’s IP or just keep manufacturing and selling the American company’s product after the American company wants it to stop.  No matter how you slice it, it is going to be faster and easier to get injunctive relief or an injunction equivalent from a Chinese court than from a foreign or even a domestic arbitration panel.  And Jones is absolutely right in pointing out that the enforcement of foreign arbitral awards in China is well under 100%.
  • “Chinese courts can be much quicker than many foreign courts. Completion of the matter in 6 months is not unusual. As do other civil law courts they rely more on documentary evidence than oral testimony, so usually there is no need for the foreign executive to attend. There is no discovery. You need to plan your evidence well in advance. The World Bank Doing Business survey ranks the Chinese court system 19th in the World for the enforcement of contracts, based on time required, cost, and complexity of procedures. I think that this ranking reflects the points that I have used above.”  I completely agree.  We have been involved in cases where the court has granted us our remedy within a couple of months.
  • “My practice consists of a lot of distribution agreements and IP licenses. The amounts in dispute rarely get up to $5 million, the IP needs injunctive remedies, and the Chinese party usually does not have assets outside the country. So we usually recommend Chinese law and Chinese courts. We have experience litigating in the Chinese courts.”  Ditto for my law firm, but I would add in manufacturing contracts to the list where Chinese law and Chinese courts almost always makes sense, and for the same reasons as for the IP contracts. I also want to mention that if your contract is going to call for Chinese law and Chinese courts, you pretty much have to make your contract in Chinese.  For more on how to write a China contract, check out China OEM Agreements. Why Ours Are In Chinese. Flat Out.

In Litigating In China. Don’t Lock Yourself Out, we wrote of how the most common mistake we see with foreign company contracts with Chinese companies:

The most common mistake we see by foreign companies is using a contract that is not enforceable in China. By doing this, they ensure the contract is not enforceable anywhere in the world. How does this happen? They do this by writing a contract with these features:

•  The contract is governed by US law.

• The exclusive forum for dispute resolution is litigation in a US court.

• The language of the contract is English.

Foreign companies are frequently quite proud that they have “forced” the Chinese side of the contract to accept these onerous terms. Apparently they think the terms protect the foreign side because it forces the Chinese side to file a lawsuit outside of China and subjects them to foreign law and procedure. However, this is an illusion. How many times does a Chinese manufacturer file a law suit? The party that will normally want to file a law suit is the buyer of the product, not the seller.

The Chinese side is usually happy to sign an agreement with these dispute resolution terms because it fully understands 1) that if it wants to sue the foreign company, it will need to sue it in their home (foreign) country since very few countries enforce Chinese judgments and 2) it also knows that it will have now ensured that it is nearly free of any risk that an enforceable judgment will be entered against it. In other words, the Chinese company knows that it has just been “forced” by the foreign side to execute an unenforceable contract. Since the terms of the contract cannot be enforced, the Chinese side can then be quite relaxed about the contract terms.

Why does this happen? The reason is that at the start of litigation, a Chinese court will first look at the dispute resolution provisions of the contract. If the contract provides for dispute resolution (litigation or arbitration) outside of China, the court will refuse to hear the case. There are no exceptions to this. With respect to arbitration, as with most countries, Chinese courts will only allow arbitration in China if there is an explicit, exclusive China arbitration provision. A common trap is a contract that provides for an alternative of litigation outside of China or arbitration inside China. In that case, the Chinese courts have traditionally refused to honor a Chinese arbitration award because the arbitration provision is not exclusive.

It is therefore critical for every company that does business in China to ask a fundamental question: if there is a dispute under this agreement, am I most likely to be a plaintiff or a defendant. If your company will be a plaintiff, then you must ensure that your contract is fully enforceable in China. It is a complete disaster to close the door to the Chinese litigation and arbitration by insisting on litigation outside of China. The next step is then to draft your contract to maximize the chance that you will get a good result in China.

Even though this all seems obvious, I find that almost every week I have to give a potential client the bad news that their contract is unenforceable through their own efforts. When I get a call from a client who wants to collect on a debt or resolve a business dispute with a Chinese company, the first thing I ask about is the dispute resolution provisions in their contract. The client then emails me the contract and I discover that the contact is governed by Arizona law with exclusive jurisdiction in the Arizona courts. I then ask: does the potential defendant have any assets in the US The answer to this question is nearly always “no,” at which point I then have to tell them that their contract is unenforceable and they will have to consider another method for resolving their dispute. This is usually a conclusion that causes distress for the client, because this kind of provision is often included at the tail end of a long and detailed (and expensive) 50 page contract. Needless to say, it is much better to have a 7 page contract that you can enforce than a 50 page contract that is waste paper.

I hate to say this, but I think that the foreign arbitration versus China litigation split oftentimes is between law firms who are not comfortable working with Chinese language documents and law firms calling for Hong Kong arbitration on the one hand, and law firms that are comfortable working with Chinese language documents calling for China litigation on the other.  I would be remiss in mentioning that foreign (i.e., non-Chinese law firms) are allowed to participate much more actively in an arbitration than they are in a China court litigation, and so there is also oftentimes a split between those firms for whom international arbitration is a large part of their practice (they typically call for arbitration) and those firms for whom it is not.

And if the above is just not enough for you on China litigation versus China arbitration, I urge you to read the following:

Any questions?

Last year, while back at my law school on a speaking engagement, a Chinese law student made the comment that I am always negative on China.  I felt really bad about that and insisted that I am neutral and just calls ’em as I see ’em.  Since then, however, whenever I am quoted defending China’s legal system, I think of that student.

I thought of that student today when I read a China Daily article that has me defending China’s intellectual property protections:

Dan Harris, founding member of Asia-focused commercial law firm, Harris Bricken, based in Seattle, says Chinese courts are starting to get tougher on IPR violations and while that is a good thing, particularly with respect to trademarks, the courts also need to be tougher in enforcing them.

“China’s laws are fine. It’s not just a question of the laws. It’s really a question of implementation. A lot of times it’s a question of implementation not just by the Chinese government but by companies that are doing business in China.”

“A lot of times foreign companies complain about IPR in China, when in reality it was the foreign company that made the mistake of not sufficiently protecting it intellectual property rights when it went to China.”

Harris says China is a lot better now compared to a decade ago, because the country is getting wealthier, and because Chinese companies are starting to become more conscious about IPR.

“I am of the view that countries start doing well with IPR when their own powerful companies really start caring about it. And I’ve seen this progression elsewhere, such as in Japan and South Korea.

“The reality is nobody is going to be able to force China to improve its IP from the outside, but big companies within China, like Haier, Huawei, and Lenovo can do so,” he says.

In fact, Chinese companies, though largely defendants, have a good record of winning IPR cases overseas. Huawei, which has been involved in many disputes with strong rivals such asMotorola and ZTE, provides a good example.

“Interestingly enough, in my experience, Chinese companies that come to the United States take IPR protection more seriously than American companies that go to China,” Harris says.

“I think a lot of the reason for that is because in the United States certain IPR protections are automatic without any need to file for them. So when Chinese companies come over here, in most cases they are prepared to file, whereas when the Americans go over to China, oftentimes they neglect to IPR do the necessary filings.”

Not saying China IP protections are great overall (because they certainly are not), but I am saying that if you are a foreign company and you fail to take the necessary steps to protect your intellectual property in China, it’s your bad, not China’s.

What do you think?

When it comes to enforcing US court judgments in China, the law has been clear and remains clear.  China won’t do it.  Not now.  Not later.  Maybe not ever.

We are always writing on how because Chinese courts will not enforce US court judgments it is usually pointless to pursue litigation against a Chinese company in the United States if the Chinese company’s only assets are in China. So if you have an agreement with a Chinese company that requires litigation take place in a US city, you are likely to face problems if you ever need to sue. Here are some of our posts on this:

So today when a lawyer from a Middle East country emailed me to discuss enforcing a large judgment from that (intentionally unnamed) country in China, I had to figure out whether China enforces that country’s judgments or not (it doesn’t).  In doing that research, I came across this very helpful chart put out by the Practical Law Company, listing what countries enforce what foreign judgments.  This chart does not list the enforcement rules for every country, but it does list it for the following 32 and I am guessing that will cover at least 90 percent of the searches out there: Argentina, Australia, Brazil, British Virgin Islands, Canada, Cayman Islands, China, Cyprus, Egypt, France, Germany, Hong Kong, Hungary, India, Indonesia, Ireland, Italy, Japan, Lithuania, Luxembourg, Luxembourg, Malta, Mexico, Romania, Russian Federation, Singapore, South Africa, Sweden, Turkey, USA, United Arab Emirates, and United Kingdom.

So next time you find yourself wondering whether a particular country will enforce another country’s court judgment, I urge you to check out this chart.

Just received a long email from a lawyer friend of mine at a well known international law firm, in response to our post the other day on Myths About China Law And Business.  This lawyer wishes to remain anonymous, but here is what he had to say:

Your post on China legal myths is great. You list as a China myth “don’t do a contract with the Chinese because they will not comply anyway.” Your response deals with an entirely different issue. The statement quoted is not really a myth. It is simply a nonsense statement that does not make sense. It is EXACTLY in the case where you think that a party will not comply that you enter into a binding written contract. If you were sure that the Chinese side will comply then you would not need to bother with a contract of any kind.

The issue that is not nonsense deals with a different statement: “Don’t do a contract with a Chinese party because the courts will not enforce the contract.” That is a logical statement. The question then becomes an empirical one: is the statement true or not? My experience shows that the Chinese courts will enforce a contract written in Chinese between parties of relatively equal status that is governed by Chinese law and enforceable by litigation or arbitration in China. You and I have discussed this many times and I know that you agree with me on this.  Of course there are many who say we are not right about this but those people always seem to rely on anecdotes concerning contracts that we fully agree will NOT be enforced in China.

You and I fully agree that the following types of contracts will NOT be enforced in China:

  • Contracts that by their terms are subject to foreign law and foreign jurisdiction.
  • Contracts solely in the English language.
  • Long, complicated, common law style contracts, even when they are translated into Chinese.
  • Contracts where the Chinese company has special status because it is a military company or is owned by a powerful official or is a locally very powerful SOE [State Owned Entity].

In my experience, contracts with small to medium private Chinese companies are enforced by Chinese courts.  As noted, almost always when people refer to their own problems in enforcing contracts in China, the contract falls into one of the above categories.

Maybe you could write a blog post on this.

I just did. What do you think?

Not sure why (the still bad economy?) but my law firm has been getting a rash of China joint venture deals and possible deals over the last six months or so.  Many of these have involved a United States company that wants to enter into a Joint Venture with its China manufacturer so as to work jointly on manufacturing and marketing and selling some combined product or products around the world.

An email from one of our lawyers to a client doing such a China joint venture recently crossed my desk and I am setting it out below because it provides a good introduction to what is involved in “doing” a China joint venture.

There are two steps in forming an equity joint venture in China. The first is to enter into a written joint venture agreement between the Chinese and foreign participants in the joint venture. The second is to formally register the joint venture as a corporation under Chinese law.

With respect to these two steps, please note the following:

a. Since the JV agreement is required, we will move forward with drafting that document first. Issues related to the JV and its structure can be worked out in the process of drafting this document.

b. Please indicate at this time who you will want to use to actually register the joint venture company. There are several options:

  • The Chinese JV partner can be responsible for the registration process.
  • You can engage the services of the local investment development bureau to handle the registration.
  • You can engage our law firm to manage the registration process. If you want to use this option, I can begin working with you to obtain the required    documents and information required for JV company registration.

For the JV Agreement, I have the following questions:

  1. You have provided your desired company name. Please provide that name in Chinese. English versions of company names have no legal effect in China.
  2. Please provide a one or two paragraph statement of exactly what the joint venture company will do in China. In particular, please describe:
  • The proposed facility.
  • If you will manufacture, what will be manufactured and what will be the source of the materials.
  • If you will import, what exactly will be imported.
  • Where will product be sold? In China, for export or both? What entity will handle sales of product.
  • Will any foreign intellectual property be transferred to the JV?

Please note that, in general, Chinese JV companies are free to sell their own manufactured product. A JV company is also permitted to import product manufactured by its shareholder parent. However, in general, it is not possible for a JV company to operate both as a manufacturer and as an importer of product manufactured by companies other than the shareholder. In your emails, you indicate that you desire to obtain approval for what is normally prohibited. If this is the case, we will need to review this issue with the local governmental authorities. If they will provide you with a special approval, you should understand what that is and then make sure that you hold them to their agreement.

Please also note that a primary requirement for company formation in China is that you have a lease on a premises that is approved for the business approved for the company. For a manufacturer, this means a factory, for a trader, this means a warehouse. However, it is also possible to have an initial address that is simply an office in a case where the business plan contemplates later selection of an appropriate factory/warehouse site. Some jurisdictions will permit this, some will not.

Your proposed registered capital is $2,000,000. This means that the Chinese company will need to contribute the RMB equivalent of $400,000 in cash. Are they  aware of this requirement? Do they have the cash? I assume that your group is also planning to contribute cash. As you mention in a related email, it is best from the start to develop a basic plan for contribution of the capital. There should be a basic business plan that provides how much will be contributed, when it will be contributed and for what it will be used.

China’s legal rules for contribution of capital are as follows:

  • 15% of the total amount of the registered capital must be contributed within 90 days after registration approval.
  • The remaining amount must be contributed within two years.

It is common for local governments to impose even stricter requirements and we will need to check with the local government officials on this point. Note that they do not have the power to make the requirement LESS restrictive; they only have the power to make the requirement MORE restrictive.

You asked us how we plan to draft documents that provide for the contingency of your key Chinese counterpart dying.  Since the shareholders in the JV are corporations, the death of any one person is irrelevant to the future life of the joint venture. We will write the JV Agreement to say that your Chinese joint venture partner company has the right to select a single director for the joint venture and that the director will be Mr. ______ at the outset.  However if you believe that the participation of Mr. ______ in management of the JV is critical, you can provide the following:

  1. Mr. _______ agrees to act as a director.
  2. If Mr. ______ is not able to be a director for any reason (refuses to serve, disability, death, etc.), then the foreign shareholder [you] has the right but not the obligation to purchase the stock of the Chinese shareholder. The purchase price will be $400,000, which is the initial amount paid by the Chinese shareholder. It is your choice whether or not you want to add this provision to the agreement. You could also provide the following: in the event that Mr. _______ is not able to be a director for any reason, then 1) all three directors will be chosen by the foreign shareholder but 2) the Chinese shareholder will have a continuing right to 20% of the profits of the joint venture company. I personally prefer the second alternative since it does not require restructuring the stock ownership.

There are a number of alternative ways to deal with this issue. Please consider the options that I have proposed and let me know whether you need additional information in to make your decision on how to proceed.

You are right to ask about dispute resolution.  Dispute resolution should be in China. You can use the Zhanjiang Courts or arbitration at CIETAC in Shenzhen. Arbitration in Hong Kong will be of little to no benefit to you in resolving any disputes because Chinese courts do not recognize their decisions regarding the corporate governance of Chinese companies.  We will need to discuss the pros and cons of Chinese courts and Chinese arbitral bodies.

We also will need to discuss who you will want to be the Representative Director. The day to day business of a Chinese companies is conducted by the general manager, not the representative director. The representative director role is limited to executing important contracts. This can be done by that person without any need to be physically located in China. In any Chinese company with a foreign representative director, there is always a challenge in allocating responsibility between the two individuals. The key issue is usually control of the company seal (“chop”). However, it is always best to appoint officers who are willing and able to travel to China freely. This is not a requirement, but it does make it easier to operate the company.

In answer to your question about scheduling contribution of capital, yes you are correct that it is an important issue for China joint ventures and one that should be resolved before executing the joint venture agreement.

I trust that the above answers your initial questions and lays out a bit of what we will need to be working on over the next few weeks.  If you have any additional questions based on the above, please don’t hesitate.

Though my law firm has been involved in a number of China litigation matters, I was not familiar with how it is that Chinese courts decide what cases to accept.  I know a lot more now, after reading the Chinese Law Prof Blog’s post, “Case acceptance in Chinese courts.” First off, let me say that I am not aware of any case involving any of my firm’s clients not getting accepted by a Chinese court. It is possible we had a client sued in a Chinese court, but whose lawsuit was rejected and so we never heard of it.

But of the cases we have helped bring in China, none of them were rejected, and it would have shocked me if any of them had been. It would have shocked me because all of them were pretty much your garden variety breach of contract action.

Yet I have read of important cases being “accepted’ or, in some (usually politically charged) cases, being rejected for filing and I never quite understood that. The Chinese Law Prof Blog explains it all quite nicely and does so by distinguishing the “gate-keeping” function of the Chinese courts from those in the United States. To simplify, in the United States, there is pretty much no gate-keeping at all and one can file and have accepted a complaint that says pretty much anything. I could sue someone for not reading this blog often enough and get a complaint to that effect filed. Of course my case would be terrible and the defendant would no doubt get it dismissed in fairly short order and probably get monetary sanctions against me as well. But I would get it filed and the defendant would need to do something to respond. Hence, the saying that “you can sue anyone for any reason.

It’s not like that in China:

[Y]our complaint “must first pass through a gate-keeping procedure in which a special division of the court (the case filing division [立案庭]) decides whether or not to accept (受理) and docket (立案) the case. According to Art. 108 of the Civil Procedure Law and Art. 41 of the Administrative Litigation Law (the applicable law depends on the kind of case), courts must, unless an exception applies, accept cases that meet the following standards:

  1. the plaintiff has a direct legal interest (a term of art) in the case;
  2. there is a specific defendant;
  3. there are specific claims, facts, and causes of action; and
  4. the lawsuit is within the court’s geographical and subject-matter scope of jurisdiction.

The decision to accept or not is a pre-trial procedure that is undertaken on the basis of the complaint and evidence you may be asked to submit; if the court doesn’t accept the case, you never get the chance to prove your claims at trial. Moreover, it’s made in something of a black box without the benefit of adversarial arguments. When the system works as intended, the case filing division makes its own initial determination of the merits, deciding whether there is enough there to warrant going forward. In practice, a court trying to avoid a nettlesome case can use the case filing stage to reject the case.

The big difference then between China and the United States is that in China your case can be rejected without your having had any chance at all to argue why that should not have been the case:

In both of these [United States] gate-keeping proceedings, both parties appear and make arguments, and the court gives a decision that can be appealed. But this is precisely what doesn’t happen in the Chinese case filing stage, and that has led to dissatisfaction and criticism. There are always cases where, for one reason or another, a court won’t want to give a judgment declaring the plaintiff the winner (e.g., powerful people or institutions will be offended), but at the same time doesn’t want to declare it the loser, either (e.g., the evidence in favor of the plaintiff’s case is overwhelming). The best thing to do in these case is simply to avoid taking the case.

The Chinese Law Prof then talks of how he has “long thought that this [Chinese gate-keeping] system deserved more attention in the English-language literature on Chinese law” and then cites to the following two articles:

  1. Nanping Liu & Michelle Liu, “Justice Without Judges: The Case Filing Division in the People’s Republic of China,” 17 U.C. Davis J. Int’l L. & Pol’y 283 (2011)
  2. Mark Cohen, ““Case Filing” In China’s Courts and Their Impact on IP Cases,” China IPR blog, March 24, 2012

This acceptance/rejection system is in many ways the ultimate nightmare for lawyers.  Just imagine you are a lawyer and you have encouraged your client to bring a lawsuit. You then spend weeks/months gathering up the facts and drafting the complaint  for that lawsuit. You then find local Chinese counsel and pay that lawyer’s retainer/fee.  You then pay the filing fees.  After all this, you get back a notice that your complaint has been rejected, without even a chance to argue otherwise.  I don’t like it.

What do you think?

I am often asked (usually right after I quote our fee) whether a China contract I am proposing to write “is even enforceable in China.” I always give the same answer, which is more or less the following.

There are three reasons why it makes sense to have a contract with your Chinese counter-party, and only one of those reasons is enforceability in court.

1.  Clarity. The first is to achieve clarity. To make sure you and the Chinese company are on the same page. For example, if you ask your Chinese supplier if it can get you your product in 20 days, it will say “yes” pretty much every time. But if you put in your contract that the product needs to ship in 20 days AND for every day it is late, the Chinese company must pay you 10% of the value of the order, there is a great chance the Chinese company will get honest with you and tell you that 20 days is impossible. At that point, you and the Chinese company can figure out what is realistic and then you know what to expect, realistically, going forward. Needless to say, I can give countless examples of this sort of thing, but this is yet another reason why we advocate putting your contract in Chinese. Clarity before you start the relationship. It is more important than you think.

2.  Stricture The second benefit of having a contract with your Chinese counter-party is that it will likely bring that company to heel. By this I mean that just having a well written contract that is at least potentially enforceable means that the Chinese company knows exactly what it must do to comply. And, in most cases, it might as well. Let’s use the 20 day example as the example here as well. If your Chinese manufacturer makes widgets for 25 foreign companies and 5 of those have very clear time deadlines with a very clear liquidated damages provision, and the Chinese company starts falling behind on production, to which companies will the Chinese manufacturer give production priority? Of course it will put the five companies with a good contract at the front of the line.

3.  Enforceability.  Here’s the funny thing. My firm has written hundreds and hundreds of China contracts and we have never once been called on to litigate any of them nor am I aware of any of them having been litigated. I attribute this to reasons #1 and #2 above, but I have to admit that this also means I cannot stand up and scream that Chinese courts enforce well written contracts. Even better though, I can stand up and scream that they do certainly seem to prevent problems. Even though I cannot speak regarding the enforcement of my firm’s contracts, I can say that where my firm has sued or threatened to sue or arbitrated or threatened to arbitrate on contracts written by others, we have felt that China does enforce contracts. More importantly, however, the World Bank feels the same way, ranking China 16th among 183  countries in terms of enforcing contracts.

And that is a lot of the point. If your Chinese counter-party believes your contract will be enforced or even if it just believes it may be enforced, it is likely to act accordingly.

China contracts worth doing? If done right, you’d better believe it.

What do you think?

A bit late on this I know, but I will be speaking today (it is not yet even 6 am here) at The Offshore Investment Conference Shanghai 2011. My topic (a bit different than noted on the program) will be “Avoiding and Winning China Disputes. I will be speaking at 4:30 pm and then I will be part of a panel at 5:15 pm. The conference is at the Shangri-La Hotel in Pudong.

The difference between my new title (created yesterday) and that on the program is subtle, but important. The title on the program makes the thrust of my tallk to be how to avoid Chinese courts. Implicit in that is the idea that one should always strive to avoid Chinese courts, at all cost. I vehemently disagree with that, as I think there are many instances where the only sensible way to resolve a dispute with a Chinese company is in a Chinese court. As regular readers of this blog well know, we are always stressing that getting a court judgment against a Chinese company in New York or in London will almost certainly be of no value if the Chinese company against whom you have secured the judgment has no assets in those cities. We are also always emphasizing that if you want to stop your Chinese counterpart from doing something (let’s say, continuing to manufacture your product after you have terminated them), your best bet will almost certainly be to get an order/injunction from a Chinese court.

So if I am not going to be telling the audience how bad Chinese courts are and how to avoid them at any cost, on what will I be speaking?

I am going to be talking about what it takes to avoid disputes with your Chinese counterpart anywhere. And that really is the goal, is it not?  And also, as part of that, how to set up your contract/relationship so as to maximize your chances of prevailing in any dispute at a low cost. And to get a little circular on you, I will note how a contract/relationship in which your chances of winning at a low cost are high will be the kind of contract/relationship that your Chinese counterpart is not going to want to “mess with” and that too reduces the chances of your ever getting enmeshed in a dispute.

I will put my PowerPoint on here after I have completed my speech.